Israel's prime minister, Binyamin Netanyahu, met President Barack Obama yesterday and said that he wants to begin immediate peace talks with the Palestinians aimed at self-government, but he stopped short of explicitly committing Israel to Palestinian independence.

At discussions in the White House expected to shape the direction of one of the toughest political challenges either leader will face, Obama said he told Netanyahu that the goal of "an extraordinary opportunity" for peace must be "allowing the Palestinians to govern themselves as an independent state".

The US president was expected to press Netanyahu to make an explicit commitment to that end at the talks but, whatever was said in private, the Israeli prime minister shied away in public.

"I want to start peace negotiations with the Palestinians immediately," he said. "I want to make it clear that we don't want to govern the Palestinians. We want to live in peace with them, we want them to govern themselves without [control over] a handful of powers that could endanger Israel. There'll have to be compromises by Israelis and Palestinians alike."

Obama said he was confident that Netanyahu "is going to seize this moment".

But Netanyahu's failure to speak of an independent state – instead talking of "an arrangement where Palestinians and Israelis live side by side in dignity, in security and in peace" – and his insistence that the Palestinians be denied certain powers, such as control over their own borders and airspace, is a reminder to Obama of the difficulties he is likely to face in dealing with Israel's well practised tactics of prevarication and obstruction.

The US president laid down a marker by which to judge Netanyahu's intent, in demanding that he fulfil previous commitments that successive Israeli governments have broken to halt the expansion of Jewish settlements in the occupied territories.

"Israel is going to have to take difficult steps," Obama said. "Settlements have to be stopped in order for us to move forward. That's a difficult issue, I recognise that. But it's an important one and it has to be addressed."

But Netanyahu offered no such commitment in public.

He said a precondition of any agreement is for the Palestinians to recognise Israel as a Jewish state, which Hamas has refused to do. That in turn is likely to mean that the Israelis will insist on negotiating only with Fatah, a move likely to deepen the divide in the Palestinian camp.

But Obama suggested that Hamas should be brought in to the talks, when he spoke about the failure of isolation in dealing not only with the Palestinian group but also Hezbollah and Iran.

Obama said Netanyahu had been "very vocal" in expressing his concerns about Iran developing a nuclear weapon, which the Israeli prime minister described as "the worst danger we face". He agreed that it should be prevented, but said that diplomacy not confrontation should be given a chance.

"Understand that part of the reason that it's so important for us to take a diplomatic approach is that the approach we've been taking, which is no diplomacy, obviously has not worked. Nobody disagrees with that. Hamas and Hezbollah have got stronger. Iran has been pursuing its nuclear capabilities undiminished. Not talking clearly hasn't worked," he said.

But he warned that talks should not become an excuse for inaction "while Iran proceeds with developing and deploying a nuclear weapon".

He said he would like to see progress by the end of the year and, if there is no change in Iran's position, he would consider a range of steps "including much stronger international sanctions".

"Iran obtaining a nuclear weapon would not only be a threat to Israel and to the United States, but would be profoundly destabilising in the international community as a whole and could set off a nuclear arms race in the Middle East that could be extraordinarily dangerous for all concerned, including for Iran," Obama said.

He said the settlement of the Palestinian-Israeli conflict and the Iran nuclear issue had a bearing on each other. "To the extent we can make peace between the Palestinians and Israelis then it strengthens our hand in the international community in dealing with a potential Iranian nuclear threat."

Netanyahu agreed, but added that Iran developing a nuclear weapon would have a negative effect on the search for peace with the Palestinians.

Both agreed that the issues make it necessary to draw in other governments in the region.

Obama is likely to urge Arab states to recognise Israel as part of a package that would include its withdrawal, not only from the West Bank but also the Golan Heights, after they were captured from Syria in the 1967 war.

The Egyptian president, Hosni Mubarak, and the Palestinian leader, Mahmoud Abbas, are scheduled to meet Obama in Washington next week. In early June, Obama will travel to Cairo to deliver an address to the Islamic world.